Practitioners vs Professors

This note was originally published
at 8am on October 17, 2011.
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“Policy is the name we give to our future mistakes.”

-Henry Wallich

The late Henry Wallich (1988) was an economist, central banker, and Yale professor. He served under Eisenhower and was also a prolific columnist for Newsweek who was well known for his ability to connect with the common American citizen. He was accountable and accessible.

Yale University hosted a “Panel Discussion on the US Economy - How Do We Create More Jobs” last week that caught a lot of us in the ranks of Yale Alumni off guard. It wasn’t so much Yale’s esteemed James Tobin Professor of Economics, John Geanakoplos, suggesting that we “try inflation as a policy” that would have Wallich rolling over in his grave, as it was the glaring amount of partisanship on the panel.

To challenge the Yale Economics Department formally to a debate would be challenging the perceived wisdoms of Big Government Interventions and Keynesian Economics on their merits – so I will.

1. Richard Levin - opens by saying “we did not stimulate enough”… and goes on to suggest the US government should have acted as boldly as the Chinese did (which is interesting in and of itself, given that’s not a democracy). Levin thinks it’s “simple” - if we spent even more tax payer moneys, we’d have been fine. This is the Paul Krugman school of thought. Period.

2. William Nordhaus – says the word “occupy” is the wrong word – he thinks it sounds like the “West Bank.” In terms of “substance”, he says “even if they are right”, it won’t work unless they have “well defined policies” (again assuming that all Americans think more policy is the answer to America’s problems, as opposed to less).

Nordhaus, like Levin, thinks Obama is right and we need a “jobs bill times 3” and “need to stop attacking the Federal Reserve.” He states plainly that any other idea is “partisan” (implicating himself as partisan). He addressed trivial points like the Gold Standard saying “give me a break … come on over to econ 122 and we’ll have a discussion.”

3. Robert Shiller – starts by saying “every crisis is an opportunity… I have written 4 books… and now I have 10 minutes to talk”… “I think we should be improving our financial markets by democratizing and humanizing” (through Dodd-Frank type reforms – i.e. more policy)…

On the Jobs Bill (that was filibustered), I like to focus on “all the good things that were in that bill… building bridges and highways, hiring teachers and policemen, etc… but it seems to have a budgetary problem… in that it would raise the national debt”… “especially in times like this when we are in near depression- we need a balanced budget multiplier” (a Paul Samuelson theory from the 1940s)

4. Aleh Tsyvinski – clearly the outlier – younger and more globally oriented in his macro thoughts (refreshing). Said what worries him in general is the “short-term focus on today’s crisis” as opposed to focusing on the “longer-term context” of large Keynesian experiments like Japan. “I am afraid we are on the verge of something much bigger and problematic in terms of long-term US economic growth.”

“Part of our employment problem has to do with the failure of policy… the theory of the multiplier effect didn’t work…” Says a lot of what we’re focusing on creating with policy could make the US economy look like Europe – slow growth, higher unemployment. “They put a lot pressure on politicians to act… but the overall objective should be long-term economic growth.”

5. John Geanakoplos – “the occupy wall st movement will be a prelude to bigger riots”… Yale campus was in riots in 1970-1971, “when I was here in 1975, we missed the revolution… but we may have another chance!”

He wants to build bridges and allow for principal forgiveness (mortgages) – but he doesn’t want to just triple the size of the spend – he wants to “plan” for it. “Most economists didn’t predict any of this… the fact is that they got it all wrong…” … “so there’s something wrong… there’s something missing from our macro economics and our federal reserve process because they don’t focus on leverage…”

Summary

Levin summarized the panel’s ideas as follows: A) short term problem = full employment B) short term problem = housing C) long-term problem = economic growth. And we can solve for all of these with MORE of what didn’t work! Short-term, focus on infrastructure and “double down.” Short-term, focus on mortgage forgiveness. Long-term we need a balanced budget (which you cannot do if you do A and B) and raise taxes.

Rebuttal

I think my daily strategy notes for the last 4 years and, more importantly, accurate forecasts in calling the last 2 major Growth Slowdowns (2008 and 2011) serve as ample repudiation of Keynesian Economics. That said, I think the most transparent and accountable way to have a rebuttal to all of the aforementioned academic dogmas gone bad is to have an open public debate.

There are 9 Yale grads on my team who would love an opportunity to explain how some of our undergrad “economics” teachings have failed our country in the real world. We can call the debate “Practitioners versus Professors” and I think anyone who’d like to find room to occupy a bi-partisan debate in their thought process will come out smarter having heard both sides.

My immediate-term support and resistance ranges for the Gold (back above its TREND line this morning), Oil (failing at its TREND line of $89.18), the German DAX, and the SP500 are now $1685-1715, $84.18-89.18, 5811-6192, and 1179-1242, respectively.

CHART OF THE DAY: Exotic Tails

Exotic Tails

“Patterns replicate through time and manifest on each level because it is a grand unified manner in which all things move.”

-Martin Armstrong

While I am certain that there are plenty Market Practitioners who have adapted to their ecosystem in the last 5 years, uncertainty in Global Macro markets continues to reign supreme.

This is actually a good thing – whoever thinks that they can be certain about a central planner’s ability to suspend economic gravity is probably feeling more uncertain about that by the day.

Chaos Theorists Embrace Uncertainty. It’s what drives our process. No matter what you think about Nassim Taleb, Martin Armstrong, and Ray Dalio, I’m fairly certain that they don’t particularly care. These gentleman have capitalized on proactively preparing for tail risks by simply not allowing themselves to be certain of anything until both Time and Patterns make whatever that is obvious.

Yesterday, it became fairly obvious that 56 exotic animals running down a man’s driveway in Zainesville, Ohio was a risk. There were 18 tigers, 17 lions, and 8 bears. The owner of the fancy pets had shot himself after his wife left him.

In response, a politician in Ohio stated, “this was an accident waiting to happen.”

Ya think?

Exotic Tails of “risk” in Global Macro markets? What we see on the screens today, they are not. Like this whacko with his “pets”, the risks are plainly obvious to anyone who isn’t paid to be willfully blind. They have been since mid-July and early August (see Chart of The Day – when Copper’s TAIL broke).

Up until that intermediate-term 2011 point, these TAIL risks had been becoming more obvious for years. Since October 2007, the SP500 has lost 22% of its value and would need to rally +28.2% “off the lows” to get back to the Perma Bull Breakeven.

Time and Patterns

They take time to manifest and you need to do a tremendous amount of cycle research, across risk management durations, in order to appreciate that at any given time things can blow up.

The US stock market is in the process of either bottoming or blowing up. I could go either way with this really (that’s why I’m hedged; 12 LONGS and 10 SHORTS in the Hedgeye Portfolio). There are no rules against changing your mind. There’s just time and space.

From a timing perspective, the situation in Europe could blow up any day. If it does, no one should be surprised. The monkeys you see swinging from their journalistic rumor trees throughout the trading day are compounding systemic risk for the sake of their short-term careers – and if it suddenly goes bad out there, as Jack Hanna said yesterday in Ohio, “you can’t tranquilize attack monkeys in the dark.”

Short-term vs Long-term

A Keynesian’s answer to accepting responsibility for policy recommendation is that “in the long-run, we are all dead.” Well, unfortunately, for those of us who have successfully managed 5 down US stock markets in the last 12 years (2000, 2001, 2002, 2008, 2011), and seen net US jobs added over the span of this past decade = ZERO, in the short-run, people die too.

What would have happened if these Bengal tigers found a way to survive the night and hit the Streets of Ohio? Ask the monkey who didn’t make it past the end of the driveway…

This is the point. We have all of this Global Macro risk all compartmentalized in cages now. Or at least we think we do. No one can get out. So no one gets hurt.

No one loses their political life. Everyone gets fed their “fair share.”

Until someone opens the cages…

And, then… since no one saw any of this coming – we’ll be on the precipice of another Great Depression again unless we all huddle back into captivity, take our commoner’s wage, and like it.

Yesterday I raised our US Equity position in the Hedgeye Asset Allocation Model to 6% from 3% (we’ve upped our beta by going long Consumer Discretionary, XLY, and selling Utilities, XLU).

I’m bullish on the US Dollar and, in the end, I believe that Americans are smart enough to realize that a Strong Dollar = Strong America.

In the long-term, Time and Patterns agree with me on this. Martin Armstrong says that it’s “the reason life perpetuates through what is called a system of self-referral.” George Soros calls it “reflexivity.” We call it Mr Macro Market.

No matter what you want to call it, it is all based on the most relevant mathematical discovery since relativity. So don’t let the Keynesians call what you see out there today, tomorrow, or the next day, an Exotic Tail.

Risk Managed Long Term Investing for Pros

WYNN: WHAT, NO SPECIAL DIVIDEND?

A fairly in-line hold adjusted quarter but the lack of a special dividend is a disappointment.

We’re not sure we’ve seen a special dividend more telegraphed than this one. The problem is…there was none. Not sure if the Board nixed it at the last minute and/or management decided to hoard some cash for the prospect of future development. Either way, the lack of a special dividend will likely be a disappointment to the fast money in the stock for that very reason.

In any other sector, WYNN’s results would look fantastic. However, the downside of operating in Macau is that investor expectations are usually at high altitude. Relative to those expectations, Q3 results were a little lackluster. Las Vegas was in-line after adjusting for hold but Macau missed our estimate because of the cost side.

Management was bullish about current trends in Macau which told us essentially what we already knew: Golden Week was terrific and October is tracking up 34-39% over last year. While the US$73 million in EBITDA through the first 18 days of October (as disclosed on the call) sounds great, that would project out to $325 million in EBITDA for Q4, essentially in-line with our projection. One cannot straight line the busiest part of the quarter over the full quarter.

Here are the details of the quarter:

Macau:

Net revenue came in $4MM higher than our estimate but EBITDA was $11MM light due to higher junket commissions and higher fixed expenses. Higher than theoretical hold on the VIP side of the business and strong hold on Mass benefited EBITDA by roughly $14MM.

Net VIP table win was $4MM higher than we estimated

Direct play was 10% vs. our estimate of 8% but hold was only 1bps lower than we estimated, resulting in gross table win that was $19MM above our estimate. However, that was offset by a rebate rate that was 3bps higher – 93bps or 31.5% of win.

We estimate that all junket commissions & rebates were 42.8% compared to our estimate of 41.2%. However, we won’t know for sure until Wynn Macau reports.

If we used theoretical hold of 2.85%, then gross win would have been $31MM lower and EBITDA would have been $5.4MM lower

Mass table win was $1MM lower than we estimated

Drop was 10% less than we estimated but the win % was 2% better. Wynn’s mass hold during the last 3 quarters has been trending at 27.8% - noticeably higher than 23.6% in 2010. The last 4 quarters have averaged 27.4% hold, so this could be the new norm for their business. However, if we use a 7 quarter average of 25.3%, revenues would have been $17MM lower and EBITDA would have been about $9MM lower.

Slot win was $1MM higher than we estimated

Slot handle was disappointing - flat YoY - but a 1% improvement in hold % made up the difference. It’s probably not a stretch to say that at roughly a $700/win per device, we are seeing some saturation here.

We estimate that fixed expenses, totaling $101MM, were $6MM higher than our estimate

Las Vegas

Revenues and EBITDA came in below our estimate by 6% and 14% respectively due to low hold, higher promotional spending, and lower F&B spend which was somewhat offset by better expense control

Net casino revenues were $13MM below our estimate

Table drop grew an impressive 15% YoY, much better than our estimate of flat table drop, but hold was only 18.3% vs. our estimate of 24%

If we use a normalized hold rate of 23.5% (the past 7 quarter average), revenues would have been $32MM better and EBITDA would have been about $16MM better.

Slot win was $1MM better than we estimated

Slot handle on the other hand wasn’t so impressive – decreasing 2.4% YoY vs. our estimate of 5.0% growth. A better win % more than made up the difference though. Wynn’s win % has been increasing over the last few years largely due to the removal of the video poker machines which had payout ratios of about 99% and what looks like some recent yield management.

Total gaming discounts and promotions totaled 17.4% of gross casino win- higher than the 15.9% discount rate from 2010 and the 15.9% rate last quarter

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10/20/11 07:18 AM EDT

CAKE: STILL A STRUGGLE

Cheesecake Factory posted poor 3Q earnings as commodity costs hit the bottom line but – perhaps less transient – the top-line also missed.

CAKE posted a disappointing number after the market close, with EPS coming in at $0.36 versus expectations of $0.38. Total same-store sales came in at 0.8% (including 40 basis points of negative impact from Hurricane Irene). Cost of sales, restaurant margins, and operating margins were all the wrong side of expectations by 10 basis points in each case. Dairy costs, which management claimed earlier in the year would be favorable in the fourth quarter, were a significant headwind in the third quarter and overall food costs are going to be more of a headwind than expected – by ~$1.00 – in the fourth quarter.

Here are our Top 10 Takeaways from the CAKE quarter:

The concept’s top-line struggled through the quarter as price was taken and gas prices were elevated. Consumer confidence is not, according to the company, improving quickly.

There was roughly 1.6% of pricing on the menu which implies, given the comp, -0.8% of negative mix shift in the quarter. Management expects the mix drag on the top-line to continue until incidence of alcoholic and non-alcoholic beverages increase.

On the brighter side, the company’s new units perform – from a sales perspective – above the average of the rest of the store base. Additionally, the new store openings have been quite geographically diverse: California, Texas, Florida, and the Northeast.

California, Texas, and Florida were highlighted for ongoing strength. It came as a slight surprise to us given the decline in California Retail Sales and Use Tax Receipts in September.

Margins were a disappointment this quarter with commodity costs the most obvious culprit. As management put it, “normalized for commodity cost, margins are healthy, as we effectively leverage costs across our P&L.

Food costs remain a wild card for the fourth quarter. Dairy prices have been extremely volatile and the company seems less confident on this line than they were prior. Cheese prices will be worth watching in our weekly commodity monitor (chart below).

From a top-line compare perspective, the fourth quarter is easy (versus a 0.9% rather than a 2.8% in 3Q).

The sentiment on the name is extremely bullish given the less-than-perfect fundaments and we believe that there is plenty of room – and reason – for downgrades to follow this poor quarter (second chart below).

The company’s guidance won’t go far towards halting any downgrades in their tracks. The company guided to $1.80-1.90 in EPS versus the Street at $1.87 and 1.5% to 2.5% comps versus the Street at 2.3%.

Strong Knapp figures didn’t seem to show in CAKE’s results. While the stock has been beaten up recently, we remain negative on the name

Howard Penney

Managing Director

Rory Green

Analyst

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10/20/11 07:08 AM EDT

THE HEDGEYE DAILY OUTLOOK

THE HEDGEYE DAILY OUTLOOK

TODAY’S S&P 500 SET-UP - October 20, 2011

Exotic TAILS notwithstanding (18 tigers and 8 bears on the loose in Ohio yesterday), we know this market’s long-term TAIL is broken (1266) – so, all we have to do now is continue to manage risk around the immediate (TRADE) to intermediate-term (TREND) range. As we look at today’s set up for the S&P 500, the range is 20 points or -0.73% downside to 1201 and 0.92% upside to 1221.

SECTOR AND GLOBAL PERFORMANCE

From an immediate-term TRADE perspective, today’s selloff doesn’t change the fact that all 9 sectors (and the SP500 itself) remain bullish. This is healthy until it isn’t. A close below 1201 tomorrow would change this setup. Holding above it would be bullish.

Another improving TREND (intermediate-term) is that 4 of 9 Sectors are now bullish on that duration: Consumer Discretionary (XLY), Utilities (XLK), Tech (XLK), and Consumer Staples (XLP). We like those Sectors in that order. Consumer Discretionary will be the most direct beneficiary of a Strong Dollar as it will continue to “Deflate The Inflation.”

SEC said to be trying to determine if SAC Capital used insider information to profit from J&J’s 2009 takeover of Cougar Biotechnology, WSJ says

COMMODITY/GROWTH EXPECTATION

COMMODITIES – we’ve called for the Correlation Crash to continue and that’s plainly obvious now with Gold chasing Copper (albeit with a lower beta); both remain broken; Copper down -2.9% this morning is immediate-term TRADE oversold, but has moved back into the down -30% since July zone; not good – neither is Gold’s TREND resistance ($1685) fortifying itself

MOST POPULAR COMMODITY HEADLINES FROM BLOOMBERG:

Pamela Anderson Champions Palladium as Gold Prices Soar: Retail

Iron’s Worst Rout in 15 Months May Deepen as China Slows

Silver Bear Market Seen Ending on Europe Crisis: Commodities

China Love of U.S. Cherries Fuels Cool-Cargo Boom: Freight

Gold Falls to Two-Week Low as Gains in the Dollar Curb Demand

EU Targets Commodities, High-Frequency Trading in Market Law

Coal Gridlock Heralds Two-Year High Asia Premium: Energy Markets

Zambia Investors Say Copper Boom to Extend as Sata No Castro

Copper Drops for a Fourth Day on European Debt-Crisis Concern

Chinese Aluminum Supply Jump 30% in 3 Weeks, Signaling Slump

Oil Drops a Second Day on Europe Outlook; Brent Premium Widens

Rio Tinto Makes $567 Million Offer for Hathor to Trump Cameco

Gold Prices May Extend Losses on Bear Flag: Technical Analysis

EU Seeks Curbs on Commodity Derivatives, High-Frequency Trading

Freeport Says Grasberg Mine Operating at Two-Thirds Capacity

Agnico Plunges After Halting Canadian Gold Mine on Flooding

Commodities trading suffers as French banks curb credit

Thailand, Indonesia ‘Closely Monitoring’ Rubber Decline

Oil Rebounds on Speculation EU Agreement Will Help Fight Crisis

CURRENCIES

EUROPEAN MARKETS

RUSSIA – consistently flashing negative divergences vs the focus European markets (DAX, CAC, Greece, etc) this week; this tells me that A) I’m right on the USD TREND and B) right on Oil remaining a bearish TAIL/TREND; Petrodollars drive the RTSI and its crashing – down -34% since May.

ASIAN MARKETS

ASIA – the Hang Seng was down -1.8% again last night (China down -1.9% testing new lows) and the move was consequential as the only remaining line of support (18215) was snapped again on the downside. As the world focuses on 1 thing (Europe) you tend to get paid to focus on everything else that doesn’t cease to exist – Asian Growth Slowing is a big one.

MIDDLE EAST

The Hedgeye Macro Team

Howard Penney

Managing Director

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